COLUMN-Saving for college? 529s plan aren't as safe as you think

LOS ANGELES, Oct 30 (Reuters) - Your 529 college savings plan may not be as safe as you think.

“Safe” is a relative term in investing, but the age-based options in these tax-deferred plans typically tilt away from stocks and toward bonds as the beneficiary - your kid - approaches college age.

Equity weightings for age-based 529 plans start out at over 75 percent, on average, for the youngest children and dip to an average of 14 percent by age 18, according to Morningstar . The idea is to reduce risk gradually and preserve your principal so the money is there when you need it.

The problem now is that bonds haven’t been doing so well, and are likely to do even less well if interest rates continue to rise. It’s Bonds 101: Bond prices drop as yields rise.

That means parents with high-school-age children are seeing unwelcome surprises in their 529 statements.

“They’re expecting that money is going to be there to pay tuition bills,” said Steve Dombrower, director of college savings plans for OppenheimerFunds. “I’ll bet the majority of [these parents] didn’t expect to get their third-quarter statement and see their portfolios were down.”

The declines haven’t been precipitous, since bonds haven’t fallen steeply so far this year. For example, Vanguard’s Income Portfolio, which is 75 percent bonds and 25 percent cash, is down about 2 percent so far this year.

Plan experts don’t expect a repeat of 2008, when parents faced big losses in late-stage 529 plans. College savings plans for beneficiaries aged 13 to 18 lost an average 18 percent that year, according to Morningstar.

Back then, many age-based plans had hefty exposures to stocks at the end of their glide paths. (The “glide path” is a predetermined investment schedule to make a plan less vulnerable to short-term market fluctuations as college nears.) Those plans suffered mightily when stocks and bonds cratered.

That was also the year the Oppenheimer bond funds blew up. While the average intermediate-term bond fund lost about 5 percent in 2008, Oppenheimer Core Bond Fund, which was featured in six states’ 529 plans, sank 35 percent because its exposure to bad mortgages and to derivatives magnified the loans’ risks.

OppenheimerFunds agreed to pay the Securities and Exchange Commission $35 million to settle charges that the firm misled investors about that fund and a junk bond fund, Oppenheimer Champion Income Fund, which sank 78 percent the same year.

Oppenheimer has since “made a concerted effort to stay a lot more traditional” in its fixed-income investments, Dombrower said. It also created a risk-management position that reports directly to Oppenheimer’s chief executive officer.

Today, the risk of rising interest rates is well known and much discussed, at least among 529 plan providers and the states that sponsor them, said Laura Lutton, Morningstar’s 529 expert and director of its funds of funds research. The problem is that no one can predict the hit the plans might take.

WHEN MODERATE IS AGGRESSIVE

Differences among the plans mean there is even more uncertainty. There’s no agreed-upon asset allocation for each age group, and there are even more glide paths today than there were in 2008. Many plans have added multiple options - typically labeled “conservative,” “moderate” and “aggressive” - for each age range.

“It’s really a cop-out,” said Joseph Hurley, a certified public accountant and founder of the SavingForCollege.com site, which tracks 529 plans. “They’re saying, ‘We can’t figure out what’s best for your kids, so you figure it out.’ ”

A SavingForCollege.com survey compiled in August of aged-based portfolios for beneficiaries 17 and older shows asset allocations are all over the map, with some accounts still invested in stocks at that late stage and others heavily weighted to bonds, with still others entirely in cash. Even labels don’t mean much: Louisiana’s “moderate” portfolio is all cash, while Pennsylvania’s is a mix of stocks and bonds.

Hurley recommends that 529 account holders investigate their plans’ holdings so they understand the risks - and can decide whether they’re comfortable with them.

It’s not just stock-bond-cash mixes that are important. Funds that are skewed toward short- and intermediate-term bonds, for example, are likely to suffer less in a rising-interest-rate environment than those holding mostly long-term bonds.

If you don’t like what you see, you have choices. Perhaps the easiest solution is to start shifting money to cash four or five years before you need it. We plan to have our daughter’s first year of college tuition sitting in the 529’s cash option by the time she’s a freshman in high school.

Or you can create your own asset allocation. College expert Lynn O‘Shaughnessy, author of the book “The College Solution,” never liked the aged-based portfolios of the 529 plan she used for her two kids. She wanted to stay heavily invested in stocks right until they started college, and was willing to take that added risk for the chance of extra returns. The gamble worked out - neither child had to take loans to get their degrees, she said.

If all this seems like too much effort - after all, the age-based option was supposed to be the “no brainer” solution - Hurley empathizes. He still thinks it’s reasonable to trust professional managers to get the mix right. Whether you do or you don‘t, however, investing in 529 plans involves risk.